Little Impact To Qualcomm From Rumored Weak iPhone Demand

Apple’s (NASDAQ:AAPL) recent stock market travails have not concerned Qualcomm’s (NASDAQ:QCOM) investors much and for the right reasons. Earlier this week, multiple reports surfaced in the media claiming that Apple has cut back its LCD screen and other iPhone component orders due to weak demand. Among the large number of suppliers that Apple accesses for its various parts, Qualcomm’s name naturally came up as one that could be hurt by the production cutbacks. However, unlike last month, when a Jefferies analyst had raised similar concerns, Qualcomm’s stock did not react negatively to the news, despite being up almost 8% over the past month. We believe that the markets behaved rationally this time, and that investors in the dominant mobile chipmaker, should not be much concerned even if Apple has actually reduced its orders.

Our conviction in Qualcomm is derived not merely from the fact that the company currently has the biggest market share in both the app processor and baseband markets, but that it also has one of the most well-diversified customer base, with enough number of hardware partners for Apple alone to have a large impact. With the smartphone market growing at impressive rates, Apple’s market share loss could very well be Android’s or Windows Phone’s gain – both of which have a big Qualcomm presence. What’s more, even the upcoming BB10 smartphones are touted to run on Qualcomm’s S4 integrated chipsets. Furthermore, with most smartphone makers going with third-party app processors such as Qualcomm’s instead of building their own (unlike Apple which makes its own app processor and only uses Qualcomm’s baseband), such a situation might even work to the chipset maker’s advantage.

Additionally, Qualcomm announced recently that the 28nm supply overhang, which had lasted for a major part of the year, is easing and will mostly be resolved as we enter into 2013. As the supply pressures ease and mobile demand continues to remain strong, Qualcomm actually looks very well positioned with its broad portfolio of chipsets and diversified customer base, to make the most of its leading position in the mobile chipset market going forward. We have a $69 price estimate for Qualcomm, about 8% ahead of the current market price.

Sustained High Demand For Mobile Devices

The mobile device market is seeing strong demand growth as mobile data usage continues to witness explosive growth. The fact that Qualcomm registered a 28% uptick in sales for the full FY 2012, despite not meeting demand underscores the fundamentals of the market in which it operates.

Smartphone sales showed significant growth in 2011, and given the 42% year-over-year growth rates seen so far, 2012 is also likely to be a strong year. Despite macroeconomic uncertainty, the consumer shift towards smartphones continues to be strong. iPhone and Android-based smartphones have registered incredibly high growth, and the launch of Windows Phone 8 smartphones should help push the market forward with more ecosystem choices. At the same time, tablet growth is picking up serious momentum. Gartner estimates that tablets grew by over 250% in 2011, and will continue to grow rapidly for the next few years, to reach about 370 million unit sales by 2016. [1]

A foot in every door

With the demand for mobile devices booming, Qualcomm is very well placed with its chipsets finding a place in two of the dominant mobile ecosystems worldwide, Android and iOS. While Apple uses Qualcomm’s baseband chipsets in both the iPhone and the iPad, many Android smartphones use Qualcomm’s standalone as well as baseband-integrated chipsets. Android and iOS account for a combined 85% of the market but the near-duopoly could break in the coming years, with Microsoft making a reinvigorated assault on the mobile space with its WP8 OS. But with Microsoft going with Qualcomm as the sole supplier of chipsets for WP8 handsets, Qualcomm has that base covered as well. (see Qualcomm Readies Itself For Microsoft’s Mobile Foray)

This dominance is clearer when we look at Qualcomm’s market share in both the app processor and the baseband market. The semiconductor giant has close to 50% market share in both markets, with Samsung, MediaTek, Intel and Nvidia sharing much smaller proportions of the rest of the pie. Qualcomm’s market share may fall in the coming years, but the growing smartphone market should more than make up for the losses. At the same time, Qualcomm will continue to benefit from the growing penetration of 3G/4G in emerging markets, as it brings in a steady stream of high-margin licensing revenues. According to our estimates, patent royalties account for about 35% of Qualcomm’s value.

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